SKARBECK: Investing wisely in market doesn’t have to be complex

This column has strived to emphasize the ingredients that lead to investing success. Principles like maintaining a long-term outlook and refraining from excessive trading. The time to aggressively buy stocks is when they are cheap and out of favor. Likewise, when valuations become stretched it makes sense to trim back or sell out.

Successful investors make rational decisions based on the fundamental characteristics of a business, a subjective analysis of the quality of management, and an estimate of the difference between market price and the intrinsic value of the company. Then the investors continually monitor the progress of the business over time.

Prepared investors act when opportunity arises. They are followers of Ben Graham’s words of wisdom that Mr. Market’s fickle behavior will occasionally serve up bargain opportunities. Buying undervalued stocks at discount prices provides a margin of safety against downside risk. Maintaining the proper temperament guides investors to avoid the market emotions that can get them in trouble. A contrarian attitude that is skeptical of crowd behavior will serve an investor well through various market environments. In the end, successful investing really isn’t terribly complicated.

Contrast that with some of the current thinking coming from the institutional investing arena. Now that some institutions have begun to question their allocations to high-cost and poor-performing hedge funds, money managers are sensing the need for a new approach to hold onto their hedge fund assets.

One large money manager is championing a strategy uniquely called “alternatives to alternatives.” The firm proposes an investment approach that takes an index fund and attempts to earn a return slightly above the index. Here is how one head of Global Investment Solutions describes what he calls “alternative beta”:

“It took several years to understand and unleash the engineering—meaning the algorithms that were necessary to access the alternative beta return streams needed time to develop. To create an alternative beta index, you would rank [an index] from top to bottom based on price to book value from the cheapest stocks to the most expensive stocks. You would go long the top 20 percent of cheapest stocks, and then go short the bottom 20 percent of most expensive stocks while removing the middle 60 percent. Then you sector-neutralize and beta-neutralize the holdings. The result is a risk premia with limited directional market bias.”

Wow! This sounds so sophisticated—surely they must have discovered the Holy Grail of investing.

The complexity that is being brought to bear in the realm of alternative investing these days is mind-boggling. Technology and complex mathematics have combined to the point where few truly understand these strategies. And frankly, there is little evidence that they work. Is it any wonder that pension fund returns continue to struggle even while rational-minded stock market investors have thrived during the seven-year bull run that has tripled in value?

So which path makes the most sense to achieve investment success? A complex and costly approach, like hedge funds and alternative mutual funds, that will most likely fall short of market returns? Or more simply, a portfolio of carefully selected stocks held for the long term?•

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Skarbeck is managing partner of Indianapolis-based Aldebaran Capital LLC, a money-management firm. Views expressed are his own. He can be reached at 818-7827 or ken@aldebarancapital.com.